A High Stakes Debate That Proceeds at a Snail’s Pace

Credit unions have a large stake in the debate over how to reform the secondary mortgage market but may need exceptional patience and endurance to see it through to the end.

To recap, the failure and conservatorship of the two government sponsored enterprises, the mortgage finance organizations Fannie Mae and Freddie Mac, are on course to cost U.S. taxpayers $200 billion.

That cost came about because the government guaranteed the mortgage-backed securities that Fannie Mae and Freddie Mac assembled and sold to investors–mortgage-backed securities that experienced widespread failures as the mortgages that backed them also failed. This guarantee, critics charged, essentially allowed the GSEs to reap profits from business while leaving the business risk to the taxpayers. It also allowed Fannie and Freddie to dominate the market due to having lower borrowing costs that the competitors, which lacked a government guarantee, critics alleged, and further distorted the market by undercutting the risk and caution which would normally have guided investor actions when placing large sums of money.

Although debate on the impacts of these questions as well as on Fannie and Freddie's precise role in the mortgage crisis and subsequent recession has continued, consensus has built that some sort of reform is necessary to try to prevent a similar calamity from happening again. And the debate has centered over the shape that reform should take.

The Obama administration released a set of three possible approaches to the question in February, but has left the responsibility of making a specific proposal to Congress, where the debate has largely devolved into a question of how much of a role in the secondary market the federal government should take going forward. And that debate has also been taking place, albeit more muted, within the credit union industry as well.

On one side are Jim Blaine, CEO of the $21.4 billion State Employees' Credit Union, and some other credit union leaders who strongly challenge whether CUs and other local mortgage lenders, particularly credit unions and local banks, necessarily need much of a government role in the housing market. On the other side are credit union CEOs and others who argue that having a strong federal role in the secondary mortgage market will be absolutely vital to making sure credit unions and community banks have any access to the secondary market at all.

As part of their critique, Blaine and other GSE critics note that the government guarantee effectively introduced a wholesaler between the financial institution that issued the mortgage and the investor that sells the mortgage–and that this prevented the sort of common sense due- diligence and risk evaluation that these sorts of transactions should carry.

"What we are really talking about here is whether or not you eat your own cooking," said Blaine, drawing on an a country aphorism that has migrated into the investment world to symbolize situations where organizations are willing to back their investment products by keeping them in their own portfolios.

"We, as a nation, got into this mess in part because too many people at all levels of the mortgage industry stopped being the ones who ate the meal," Blaine said. Without the middleman organization, Blaine argued, credit unions could continue to service their own members' mortgages and sell them to investors who, in turn, would know the risk profile the credit unions used, would know the sorts of mortgage underwriting the institution has, and would know, ultimately, where to come for redress if those mortgages wound up going sour.

Most strongly, he also noted that having a broader secondary mortgage market that was not dominated by one or two federally backed organizations or other federal presence could allow credit unions to offer mortgage products more tailored to their members needs.

One of the aspects of the previous secondary mortgage market was the rise of the so-called "conforming mortgage"; that is, a mortgage that conforms to Fannie Mae and Freddie Mac's guidelines and was therefore eligible for sale into the secondary market.

But Blaine argued that these conforming rules wound up turning mortgages into commodities and that this hurt credit unions.

"Turning something into a commodity always hurts the small manufacturers or suppliers," Blaine said. "Credit unions have a strong reputation as good, solid and strong mortgage lenders, but if all we're doing is cranking out mortgages that look more or less just like those of other issuers, that advantage is lost."

Blaine acknowledges that his thinking on this has been colored, in part, by SECU's experience with mortgage issuing. SECU does not, necessarily, write conforming mortgages. The CU prefers to issue shorter term mortgage loans that Blaine argues better suit the CU's members and usually sells only to private investors. Some of its mortgages are also above Fannie Mae's guidelines on loan-to-value based on the member's situation and carrying a somewhat higher interest rate. Because SECU services all its loans, the credit union is able to step in relatively quickly with its own mortgage modification program as well, giving it one of the lowest mortgage default rates of any CU in the country.

But other credit union executives countered that having a strong federal role in the secondary mortgage market was essential to making sure that CUs continued to have access to the market at all.

One, who declined to speak for the record, agreed with Blaine that credit unions write strong mortgages, but argued that without a federal role in the secondary market CUs would have no place to sell them.

"It would be akin to having a car lot with some great cars on it, but down the street there would a huge megalot with a whole lot more cars in it," the CEO said, "and because of the volume, they could also offer their cars at a much lower price. CUs need the GSEs to keep us in the game."

For the record, that is on the minds of the administration as well. Administration officials have gone on record several times, most recently before Congress, as being aware of the need to protect the access of smaller mortgage issuers to a reformed secondary mortgage market.

Nader Moghaddam, CEO of the $710 million Financial Partners Credit Union, headquartered in Downey, Calif., is one who agrees that credit unions and other smaller financial institutions will need the federal government to maintain a role in a reformed secondary mortgage market.

The credit union has maintained its mortgage business in the face of a very difficult real estate market and economy in California, Moghaddam reported, and part of that has meant selling more than 80% of the mortgages it writes onto the secondary market, something which he expects will have to continue as long as the 30-year fixed-rate mortgage remains as popular as it has become.

Still Moghaddam said he remains "agnostic" on how, exactly, a federal market-guaranteeing option might be structured, and he cautioned against imagining that CUs will necessarily continue selling mortgages at the same rapid pace.

"This has been a very unusual time for credit unions just like the other parts of the financial system." he said. "Credit unions have historically not sold quite as high a percentage of their mortgage loans as they have in the past two years. It is not clear that two years hence they will still want to sell as many loans or that they will want to sell them the same way."

But what executives agreed upon was the need for CUs to play close attention to the debate over GSE reform and remain vigilant about speaking up during the reform process. They also agreed that they may have to do so for a number of years. Obama administration officials have generally spoken in terms of five to seven years to compete the reforms once they finally start, and it’s unclear how long the debate over what to do will last.